Public Policy Sources #37:
Executive Summary

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One of the most hotly debated policy issues in Ottawa these days is whether or not Canada has a productivity problem. The official line of the federal government is that Canada does not have a productivity problem. Politicians at the highest level of the country have stated publicly that they think that Canada's productivity performance has been satisfactory. But, studies released by several organizations--including the Organisation for Economic Co-operation and Development (OECD), the Centre for the Study of Living Standards, and even one of the federal government's own ministries, Industry Canada--have made the opposite claim, that Canada does indeed suffer from very poor productivity and, without major improvements here, Canada's living standards are in jeopardy.

This study provides a non-technical overview of the issues surrounding the debate about productivity and discusses why productivity growth is essential if Canadians want a high and rising standard of living. Productivity refers to the efficiency with which an economy transforms inputs (capital and labour) into outputs (goods and services). A more productive economy requires fewer inputs to produce a given amount of output. Most economists would agree that growth in productivity--being able to produce more with less--is necessary for increases in per-capita income over the long term. Developed countries are wealthier than Third-World countries precisely because they are more productive. Estimates suggest that productivity growth accounts for one-quarter to one-third of the increase in real living standards in the period since World War II. It is for this reason that productivity growth is the cornerstone of economic growth and wealth creation.

After surveying the relevant literature and examining the empirical evidence, I find that Canada's productivity performance has indeed been poor. In particular, the data reveals that Canada's productivity growth has been among the worst in the OECD since the 1970s. Moreover, Canada is the only G-7 country to experience negative productivity growth during the period from 1979 to 1996. As a result, real income per capita has stagnated: during the 1990s, Canada's per-capita income dropped from third to ninth place among OECD countries. This is why Industry Canada and other observers believe that Canada has very poor productivity.

While there is much disagreement about the productivity statistics themselves, it cannot be that Canada's poor productivity performance is simply "measurement error." In this study, I discuss the problems associated with productivity measurement and find that Canada's poor productivity is not merely a statistical artifact. While the rapidly growing services sector may have resulted in Canada's productivity growth being underestimated, this cannot explain Canada's poor productivity performance relative to other OECD countries--in particular, the United States--that have also experienced growth in the service sector. In addition, Canada's manufacturing productivity growth has been the weakest among G-7 countries. The annual growth rate of output per hour in Canada's manufacturing sector from 1979 to 1996 was 1.8 percent a year while the growth rate in the G-7 was 3.2 percent a year. This is cause for serious concern, for the theoretical and empirical literature supports the view that manufacturing productivity growth has important spill-over effects for the economy as a whole.

To date, little attention has been given by researchers to examining the policy issues surrounding the productivity debate. Nonetheless, it is clear that if advancing the standard of living of Canadians is indeed the objective of government policy, then the role of the state is to provide an institutional environment that is conducive to the creation and diffusion of new knowledge and new technologies--the very sources of productivity growth. This, in turn, requires an institutional framework that rewards individual effort and entrepreneurial activity. While Canada is a nation with fine institutions, it is becoming increasingly clear that without certain reforms--in particular, tax reform and more deregulation--Canada will fall behind other industrialized countries. For one thing, Canada's current tax structure is not conducive to the accumulation of inputs of higher quality--more productive machines and equipment and more highly educated personnel. There is growing evidence that high marginal tax rates on personal and capital income have imposed large dynamic efficiency losses on the economy. Additionally, many studies suggest that, in the absence of significant reductions in personal income-tax rates, Canada will lose many of its best and brightest innovators to the United States. Hence, a necessary ingredient in an economic policy that will encourage the growth of productivity is a reduction in marginal tax rates on personal and capital income.

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